Simply stated, a rollover happens when you “roll over” assets/funds from one qualified retirement plan directly into another. You must enact this transaction within 60 days of receiving the funds from the original plan, or you will face a penalty. The transfer is done tax free.

There are several rules governing rollovers. Any part of the taxable portion of a distribution from a qualified plan, annuity plan, or tax-sheltered annuity (TSA)—other than a minimum distribution—may be rolled over tax free to an Individual Retirement Account (IRA), annuity, or other qualified plan. However, if the distribution is in the form of certain periodic payments, a rollover is not allowed.

How to Make a Rollover

Rollovers can be done in two ways:

Option 1: You (the plan participant) may receive the distribution yourself, but you must reinvest it into an IRA or qualified plan within 60 days. This form of distribution (where you actually receive cash) is subject to a 20% withholding requirement. This 20% withholding rate is imposed by law on distributions that are eligible for rollover but that aren’t transferred directly to an eligible transferee plan. The employer must withhold taxes for these distributions. This means that employees receiving direct distributions will receive only 80% of their account, since 20% is withheld. However, the withheld funds may be refunded after the employee files his or her tax return, as long as the distribution is rolled over into another IRA or qualified plan within 60 days.

Since the 20% that is withheld is treated as a taxable distribution, the employee will need to make up the withheld 20% from his or her own funds to achieve a 100% tax-free rollover; otherwise, the 20% withheld will be treated as taxable. In addition to the income taxes owed on that 20%, the employee will also be required to pay a penalty tax of 10% if he or she is under the age of 59˝.

Option 2: To avoid the 20% withholding requirement, the employee may request a direct trustee-to-trustee transfer to an IRA or qualified plan. Annuities or qualified plans must allow payees of eligible rollover distributions to choose a direct trustee-to-trustee transfer. However, a qualified plan is not required to accept this form of transfer. This type of transfer is considered a distribution option, so that spousal consent and other similar participant and beneficiary rules of protection will apply.

There are many factors to consider in deciding when and how to use a rollover. Getting knowledgeable assistance from a professional can make the difference between a “rocky” rollover and a smooth, effective one.